The theory of black swan events was developed by Nassim Taleb to explain the unpredictability of very rare high impact events that are normally beyond normal human expectations. The theory of black swan events has become a metaphor for unexpected events that cause shock and awe to victims and/or observers, and that these victims/observers who after experiencing the shock and awe of the unexpected event, tend to rationalize or find explanations that fit the ocurrence of the mishap among normal events. In its true sense as its developer- Nassim Taleb- intends it to mean, the "black swan theory" refers only to unexpected events of very large magnitude and consequence and whose occurrence in nature is so rare as to be considered not just outliers but extreme outliers. This means that Black swan events are so extreme that their probability is not computable using scientific methods. Black Swan events are also so called because they are events that fall within our blind spots, are oblivious not only to the mind but also to thought due to psychological biases that make people individually and collectively blind to uncertainty and unaware of the massive role of the rare event in historical affairs. Black swan events were introduced by Nassim Taleb in his 2004 book, Fooled By Randomness, which concerned financial events. In his 2007 book (revised and completed in 2010), The Black Swan, Taleb extended the metaphor to events outside of financial markets. Taleb regards almost all major scientific discoveries, historical events, and artistic accomplishments as "black swans"—as they were/are undirected and unpredicted. He cites the rise of the Internet, the personal computer, World War I, and the September 11 attacks, and the 2007 financial crisis as typical examples of black swan events. Originally, the black Swan phrase was a common expression in 16th century London as a statement of impossibility. The London expression derives from the Old World presumption that all swans must be white because all historical records of swans reported that they had white feathers. Just like the belief about snow in africa, a black swan was impossible or at least nonexistent. After Dutch explorer Willem de Vlamingh discovered black swans in Western Australia in 1697, the term metamorphosed to connote that a perceived impossibility that might later be disproven. An example Taleb utilized to explain his theory was the events of September 11th 2001. According to Taleb, 9/11 was a shock to all common observers; and its impact and ramifications are to this day felt in the increased level of security and the adoption of "preventive" strikes or wars by Western governments. Such a coordinated, successful attack on the World Trade Center and Pentagon using commercial airliners was virtually unthinkable at the time. The main idea in Taleb's book is to not attempt to predict black swan events, but to build robustness against negative ones that occur and be able to exploit positive ones. Taleb contends that banks and trading firms are very vulnerable to hazardous black swan events and are exposed to losses beyond those predicted by their defective models. On the subject of business in particular, Taleb is highly critical of the widespread use of the normal distribution model as the basis for calculating risk. To quote Taleb "I don't particularly care about the usual. If you want to get an idea of a friend's temperament, ethics, and personal elegance, you need to look at him under the tests of severe circumstances, not under the regular rosy glow of daily life. Can you assess the danger a criminal poses by examining only what he does on an ordinary day? Can we understand health without considering wild diseases and epidemics? Indeed the normal is often irrelevant. Almost everything in social life is produced by rare but consequential shocks and jumps; all the while almost everything studied about social life focuses on the "normal," particularly with "bell curve" methods of inference that tell you close to nothing. Why? Because the bell curve ignores large deviations, cannot handle them, yet makes us confident that we have tamed uncertainty. Its nickname in this book is GIF, Great Intellectual Fraud." More generally, decision theory, based on a fixed universe or a model of possible outcomes, ignores and minimizes the effect of events that are the "outside model". For instance, a simple model of daily stock market returns may include extreme moves such as Black Monday (1987), but might not model the breakdown of markets following the September 11 attacks of 2001 or even event that happened after lehman brothers collapsed. A fixed model considers the "known unknowns", but ignores the "unknown unknowns" that constitute black swan events. References: http://en.wikipedia.org/wiki/Nassim_Nicholas_Taleb http://en.wikipedia.org/wiki/Black_Swan The Illusion of Thin-Tails Under Aggregation Nassim N. Taleb, NYU-Poly, George A. Martin, Associate Director, CISDM, University of Massachusetts January 2012